F5, Inc.

Good afternoon, and welcome to the F5, Inc. Second Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. I will now turn the call over to Ms. Suzanne Dulong. Thank you, ma'am. You may begin.

Hello and welcome. I am Suzanne Dulong, F5's Vice President of Investor Relations. Francois Locodinou, F5's President and CEO, and Frank Peltzer, F5's Executive Vice President and CFO, will be making prepared remarks on today's call. Other members of the F5 executive team are also on hand to answer questions during the Q&A session. A copy of today's press release is available on our website at F5.com, where an archived version of today's audio will be available through July 24th 2023. The slide deck accompanying today's discussion is viewable on the webcast and will be posted to our IR site at the conclusion of the call. To access the replay of today's webcast by phone, dial 877-660-6853 or 201-612-7415 and use meeting ID 1373-7373. The telephonic replay will be available through midnight Pacific time, April 20th, 2023. For additional information or follow-up questions, please reach out to me directly at s.dulong at f5.com. Our discussion today will contain forward-looking statements, which include words such as believe, anticipate, expect, and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. We have summarized factors that may affect our results in the press release announcing our financial results and in detail in our SEC filings. In addition, we will reference non-GAAP metrics during today's discussion. Please see our full gap to non-GAAP reconciliation in today's press release and in the appendix of our earnings slide deck. Please note that F5 has no duty to update any information presented in this call. With that, I will turn the call over to Francois.

Thank you, Suzanne, and hello, everyone. Thank you for joining us today. Our team delivered second quarter revenue at the midpoint of our guidance range and earnings per share above the high end of our range. These results come despite persistent macro uncertainty, which has led to broader and more severe customer budget scrutiny, impacting both our software and hardware demand. We have strong conviction that customers' constrained spending is a temporary headwind and that we are well positioned as a trusted and innovative partner for customers as they look to secure, scale, modernize, and simplify their hybrid and multi-cloud application environments. In my remarks today, I will speak to the quarter's results, the near-term spending dynamics we are seeing, and why we remain confident in our positioning and growth opportunities longer term. First, on our Q2 performance. We delivered 11% revenue growth in Q2 as a result of stronger than expected system shipments and strong maintenance renewals. Our systems revenue grew 43%. As positive as this is for the quarter, it is more a reflection of our team completing comprehensive board redesign efforts ahead of plan than it is a demand marker. You will recall that last year, rather than just wait for supply chain to improve, we initiated multiple board redesigns with a goal of designing out the hardest to get components and opening up new supply. The successful completion of this work is making it possible for us to fulfill waiting customer orders sooner than we anticipated. And as expected, we have seen no order cancellations in the process. Our global services revenue grew 8%, driven by continued strong renewal rates, which improved across nearly all cohorts. Wrapping up our Q2 results, we also delivered OPEX within guidance and non-GAAP EPS of $2.53 per share, above the top end of our guidance range. So the quarter's results were strong, but they obscure underlying customer spending patterns. Since our December quarter, We have seen customers scrutinizing budgets and deferring spend for anything except the most urgent projects. These dynamics were even more pronounced in Q2 when we saw previously approved projects going through multiple additional levels of approvals. In some cases, approvals are reaching the C-suite or board level only to be delayed or downsized. The impact of this extreme spending caution is most evident in our Q2 software revenue, which declined 13% year over year. This was well below our expectations for the year and our long-term growth expectations. We believe there are several reasons why we are seeing this kind of impact in our software revenue. These include the relative size of the software projects we tend to be involved in and the percentage of our software revenue derived from term subscriptions. First, the majority of our software growth to date has come from transformational-type projects of size, often six- or seven-figure deals. We are seeing larger projects come under more scrutiny, resulting in delays, sometimes by multiple quarters, or downsizing into smaller, more incremental additions. Second, the majority of our software revenue comes from term-based subscriptions, which have upfront revenue recognition. As a result, when we see a decline in new term-based subscriptions, as we have in the last few quarters, it is immediately evident in our software revenue, and much more so than it would be if our software was predominantly ratable or SaaS-driven. Now, there is some good news to point to in software. We have a base of software renewals which is growing. Our renewals consist primarily of second-term multi-year term subscriptions, and similar to Q1, In Q2, our software renewals performed largely as expected. In addition, our SaaS and managed services revenue is growing, and we expect it will become a more significant and predictable contributor to our software revenue over time. The spending patterns I have described were not limited to our software demand. We also experienced software systems demand in the quarter as customers pushed the capacity of their existing systems sweat their assets, and work to deploy delivered systems into production. We expect these headwinds on both software and systems will persist at least through the end of this fiscal year. As a result, we now expect low to mid single-digit revenue growth for FY23. This is down from the 9% to 11% growth we previously forecasted. I will now speak to my third point. Why we are confident that the current demand environment is temporary and why we are uniquely positioned to help customers simplify their hybrid multi-cloud challenges. We are confident that current demand levels are temporary for several reasons. First, because of the direct commentary we are getting from customers. Customers are telling us that the delays we are seeing are a matter of budgets and approvals, not competitive pressures or architectural shifts. During Q2, I met personally with roughly 100 customers and partners. It was clear from my discussions with customers that they expect F5 will be a key part of their future hybrid and multi-cloud architectures as the only company capable of securing and delivering applications and APIs in all environments. Partners, too, are leaning into the new F5, and our rapidly expanding set of distributed cloud services are accelerating that movement. Second, because of our win rates. While the direct customer commentary is reassuring, we also consistently analyze our win rates. When we look at the first half of FY23 compared to the first half of FY22, we see broadly steady win rates across our theaters and product lines, confirming we continue to win our fair share of the deals we are involved in. Third, our factored pipeline, which accounts for the probability of a deal closing, It's up from where it's been the last couple of quarters, suggesting customer activity is increasing and deals are reaching a higher level of maturity. This too is encouraging, but given what we have seen in the first half, we believe it is prudent to remain conservative on expected conversion of this factored pipeline. Fourth, our strong maintenance renewals signal customers are delaying purchasing decisions by sweating assets. We see this in the substantial attach rate increase on older deployments where you would expect the behavior of sweating assets would be most pronounced. We also are seeing a substantial increase in deferred maintenance revenue compared to prior year trends. This behavior is consistent with what we have seen during past periods of macro uncertainty. With apps and APIs continuing to grow, however, Customers can only postpone investment so long if they want those apps and APIs to remain performant and secure. In the meantime, we are focused on controlling the things we can control, including operating with discipline and ensuring we are prepared for when customer spending resumes. This includes reducing our cost base. We are reducing our global headcount by approximately 620 employees, or approximately 9% of our total workforce. We expect these actions, combined with other cost reductions, including rationalizing our technology consumption, applying additional scrutiny to discretionary projects, and reducing our facilities footprint, will drive ongoing operating leverage. In addition, we are substantially reducing the size of our corporate bonus pool in 2023 and further reducing travel. As a result, we expect to deliver FY23 non-GAAP operating margins of approximately 30% and non-GAAP earnings growth of 7% to 11%. Further, the leverage from these cost reductions, combined with our anticipated gross margin improvement, positions us to deliver meaningful non-GAAP operating margin expansion and double-digit non-GAAP earnings growth in FY24. While customers are spending only where critical near-term, they continue to face significant challenges ahead, including creating engaging digital experiences, managing resource constraints, and addressing technical debt. Their business velocity and long-term growth will rely on finding ways to connect and protect applications and APIs across distributed environments. With our unique ability to secure and deliver applications and APIs across all environments, we are differentiated in our ability to help customers with these challenges. We believe this position will drive sustainable long-term growth. As we have evaluated and adjusted our business, in addition to reducing costs, we have also intensified our investments in areas we believe will drive the highest mid and long-term impact for our customers, including software and hybrid and multi-cloud. Now, I will turn the call to Franck.

Franck? Thank you, Francois, and hello, everyone. I will review our Q2 results before I speak to our third quarter outlook and provide additional color on our FY23 expectations. We delivered Q2 revenue of $703 million, reflecting 11% growth year over year. Global services revenue of $363 million grew a strong 8% due to the high maintenance renewals and the impacts of the price increase introduced in Q4 of last year. Our revenue remained roughly split between global services and product, with global services representing 52% of total revenue. Product revenue grew 14% year-over-year, reflecting strong system shipments against an easier comparison in the year-ago quarter. As Francois described, our successful redesign efforts enabled systems revenue of $209 million, representing growth of 43% year-over-year. At $132 million, Q2 software revenue was down 13% compared to last year. Let's take a closer look at our software revenue, which is comprised of subscription and perpetual license sales. Subscription-based revenue, which includes term subscriptions, our SaaS offerings, and utility-based revenue, totals $109 million, or 83% of Q2's total software revenue. Within our Q2 subscription business, as Francois described, new term subscriptions performed significantly below plan in the quarter. In contrast, and similar to last quarter, Software renewals continue to perform largely in line with our expectations. Perpetual license sales of 23 million represented 17% of Q2's software revenue. Revenue from recurring sources contributed 65% of Q2's revenue. This includes subscription-based revenue as well as the maintenance portion of our services revenue. On a regional basis, we saw growth across all theaters, though I'd note that these trends are more reflective of shipments in the quarter than current demand. Revenue from Americas grew 7% year-over-year, representing 54% of total revenue. EMEA grew a strong 22%, representing 27% of revenue, and APAC grew 9%, representing 18% of revenue. Looking at our major verticals, during Q2, enterprise customers represented 67% of product bookings, Service providers represented 13%, and government customers represented 20%, including 6% from U.S. Federal. I will now share our Q2 operating results. GAAP gross margin was 77.9%. Non-GAAP gross margin was 80.4%, in line with our guidance for the quarter. GAAP operating expenses were $441 million. Non-GAAP operating expenses were $374 million, in line with our guided range. Our gap operating margin was 15.1%. Our non-gap operating margin was 27.2%. Our gap effective tax rate for the quarter was 25.1%. Our non-gap effective tax rate was 20.8%. Our gap net income for the quarter was $81 million or $1.34 per share. Non-GAAP net income was $154 million, or $2.53 per share, above the top end of our guided range of $2.36 to $2.48 per share. This reflects improved operating margins from strong cost discipline as well as a benefit to our tax rate in the quarter. I will now turn to cash flow and the balance sheet, which remains very strong. We generated $141 million in cash flow from operations in Q2. Capital expenditures for the quarter were $11 million. DSO for the quarter was 62 days, flat with Q1 and up from historical levels, primarily due to strong service maintenance contract renewals in the quarter and to a lesser degree, back-end shipping linearity. Cash and investments totaled $760 million at quarter end. We did not repurchase any shares in Q2. We remained out of the market as we analyzed the potential impacts of the cost-saving measures we discussed previously as well as the changes we were seeing in the demand environment and its effects on our outlook. Deferred revenue increased 12% year-over-year to $1.8 billion, up from $1.76 billion in Q1. This increase was largely driven by substantially higher maintenance renewals on our installed base of products sold four-plus years ago. Finally, we ended the quarter with approximately 7,100 employees. This number does not reflect the reductions we announced today. We expect these headcount reductions will result in annualized savings of approximately $130 million. We expect to incur approximately $45 million in severance and benefits costs and other charges related to these actions in FY23. I will now share our outlook for Q3. Unless otherwise stated, my guidance comments reference non-GAAP operating metrics. We expect Q3 revenue in the range of 690 to 710 million with gross margins of approximately 82%. With the partial quarter impacts of our announced cost reductions, we estimate Q3 operating expenses of 348 to 360 million. And our Q3 non-GAAP earnings target is $2.78 to $2.90 per share. We expect Q3 share-based compensation expense of approximately $60 to $62 million. Finally, we plan to repurchase at least $250 million worth of shares during Q3. We remain committed to returning cash to our shareholders and continue to expect to use at least 50% of our annual free cash flow toward share repurchases. I will now speak to our FY23 expectations. We expect low to mid single-digit revenue growth in FY23. Given our first half results and the environment for new software projects, we no longer see a path to 15% to 20% software growth in FY23 and are not offering guidance for the second half product revenue mix at this time. Based on current visibility and our earlier than anticipated systems recovery, we expect to see lower systems revenue in Q3 and Q4 than in Q2. We expect that we will continue to substantially work down our systems backlog over the second half of FY23. We expect FY23 non-GAAP operating margins of approximately 30% and non-GAAP earnings growth in the range of 7% to 11%. Incorporating our year-to-date results, we have narrowed our estimate for our FY23 effective tax rate to 21% to 22% for the year. I will now turn the call back over to Francois. Francois?

Thank you, Franck. Like last quarter, I'd ask that you take away three things from this call. We believe the current demand environment is temporary, and while we cannot predict when it will recover, we are confident it will for the very simple reason that applications and APIs continue to grow. We are also confident that as customers resume more normal levels of investment and begin to take on the challenges associated with hybrid multi-cloud environments, we will be a differentiated partner for them. And finally, while we have implemented cost reductions and continue to strive to achieve double-digit earnings growth, we also have intensified our investment in areas we believe will be most impactful for our customers over the medium and long term, including software and hybrid and multi-cloud. Operator, please open the call to questions.

Thank you, sir. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. And our first question comes from the line of Sammy Badri with Credit Suisse. Please proceed with your question.

Thank you. I had two questions. First thing, maybe Frank, you could help us just to understand modeling parameters for the year. And the reason why I asked that is we were not really forecasting a fairly large growth contribution from services revenue. And that's clearly looking like that's changing as of fiscal 2Q and into the second half of the year. What should we be assuming for services growth now, given things have changed and customers are sweating assets? And then kind of backing into product, you know, I think you made a comment saying you weren't going to make guidance for software growth into the second half of fiscal year 23 for software. But, you know, I kind of just need a little bit more color in that, just given the systems commentary as well. And then I have a follow-up after this.

Yeah, sure, Sammy. So, you know, we did not update the mid-single-digit outlook that we did update in Q1 on services. Obviously, We outperformed that in Q2, and for all the dynamics that you highlighted, we continue to think, you know, services contribution is going to be strong through the course of the year as customers, you know, continue to sweat assets and, you know, particularly when we look at some of the aged assets and their decisions around that. And so we don't have an update, but I think, you know, that mid-single digit is well intact and, you know, we'll see what happens. Specifically, we did not give any guidance on mix and product. And, you know, the results of looking at that services growth to what the product growth will be in that mix, you know, I will leave that to you to model. But we are not giving any specific guidance to, you know, what we think software growth is going to be for the balance of the year nor systems growth for the balance of the year.

Okay, got it. And maybe a question for Francois.

one thing we really kind of want to know is if you were to think about which customer industry group really caused the majority of the drag or the impact to the revision of the guide for fiscal year 23, which customer cohort or customer vertical really kind of caused that, if you could, you know, put your finger on one.

Hi, Sammy. So a couple of questions. indicators on that. The first is what we have seen in our second fiscal quarter is this pullback in spending has been broader and more severe, frankly, across all vertical and all geographies. And so I would say all verticals and geographies are affected at this point. If I had to pull out a couple, I would say the financial services especially in the second half of March, where we saw a number of large deals being pulled out or delayed or downsized or delayed by multiple quarters. Financial services was impacted prior to the collapse of SVB, but we did see even more caution in the financial services industry after that, and we expect that will persist. The other vertical, Sami, that I would call out is service providers, where we had a number of customers that had expectations around their budget, I would say, in our fiscal Q1, so calendar Q4. And when the budgets were settled in the February timeframe, the budgets were a lot less than they expected. And that's driven by, I think in some cases, certainly in the MSO sector, kibble sector, worries about our service provider customers perhaps losing or reducing the growth on their highest margin customers. And we're seeing that also with certain mobile operators around their planned spend on 5G. So I would say those are the two verticals that perhaps have been where we've seen perhaps the strongest differential between where they were in Q1 and where they are today.

Got it. Thank you.

And the next question comes from the line of Ray McDonough with Guggenheim Securities. Please proceed with your question.

Great. Thanks. Two, if I could. The first one, you know, Francois, can you comment, or maybe even for Frank, can you comment on... How or if new business declines accelerated from last quarter? I believe, and with that, I also believe a part of the renewals that you expected to come in came from the true forwards. How have they performed versus expectations from the beginning of the year? And is a move towards optimizing cloud spend from customers impacting those true forwards at all, given pricing is somewhat based on what customers consume per year in those contracts?

Ray, I'll start, and certainly if Francois wants to pick up, he can. I think, you know, we saw a challenge in new business sales in both Q1 as well as Q2. Did it accelerate in Q2? Probably slightly versus our expectation, but not necessarily when you take a look at the raw number. So that's how I'd answer that one for you. I think in terms of your second question around cloud spend, On the true forwards that we saw, those were slightly below our expectation level. We do keep that in the renewal bucket. And so when we said that it largely performed to our expectation, that was the one piece that did not perform to our expectation, where we think that people are being a bit more critical around, you know, their consumption and being much closer to what They had planned to consume and not going over, and that's not what we experienced up until this year.

Okay, that makes sense. And then maybe a follow-up, Frank, for you. Can you help us on the direction of cash flow margins for this year and where you think they can go? You know, you have the benefit of supply chain challenges subsiding somewhat at least. You're lapping the initial cohort of term license. And now you have the benefit or will have the benefit of some of the cost reductions hitting this year that you're putting in place. So is it reasonable to think that a mid 20% cash flow margin is achievable this year? Or is there still some noise in the model that would preclude you from hitting that sort of target or range?

Yes, Ray. So we don't specifically guide to cash flow. And, you know, I think the dynamics that you mentioned are the similar ones to the ones that we are experiencing. So we did have some unusual cash hits to last year in relation to component costs and other supply chain challenges that we do anticipate are going to work their way out of our model by Q4. You saw some of that happen in the Q2 timeframe. You'll see more of that happen in Q3. But we don't guide to a specific margin percentage because we don't guide to cash flow.

Okay. Thanks for taking the questions. Appreciate it.

And the next question comes from the line of Tim Long with Barclays. Please proceed with your question.

Thank you. I have two as well on software. First, you guys said a few times the renewals came in as expected. It would be helpful if you could give us a little color about what you were expecting there. Were you expecting them to be down or up? So any color you can give us on what your kind of expectations were for the renewals business. And then second, similar to your previous question, but if you could talk about kind of the weakness more on a product and solution lens. So, you know, how much of this is the core virtual ADC? how much of this is maybe not fully monetizing in GenX, how much of this is not really able to bundle other software offerings on top of virtual ADCs. So anything you can give us kind of on that, what's missing when you look back at the acquisitions and what it was supposed to do for the software business, what's not happening? Thank you.

Thank you, Tim. I'll start with the second part of your question, and Frank will come back to the renewables question. So if we could, so let me start with the product piece. Where we have seen an impact, Tim, is in the ADC area. We are impacted both on hardware and software. And then what I mean by that is really traditional ADC, both systems and software systems. And we are seeing very strong evidence that this is our customers sweating their assets. And we are seeing that from, you know, the service renewals and the attach rates. In some cases where we're able to measure it, we can see the utilization of some of our platforms have gone higher than customers would typically go. And even in, you know, customer conversations, it is clear that where they can avoid spending right now, they are avoiding it. or delaying making these purchases later. In security, part of our security business is attached to ADC, and that part of the business we have seen an impact, and it is affected. And we're also seeing a bigger impact in the service provider vertical in security, whether they've tried to reduce their capex pretty quickly. Our software security business is more resilient. And our SaaS and managed services security business actually continues to grow, albeit at a lower rate than last year, but continues to grow. So if you parse it out, I would say those are the areas. And of course, with NGINX, we have continued to see growth there. Of course, the growth rate is also impacted, but we continue to see growth there. When you step back from this, Tim, and you mentioned the overall portfolio and acquisitions, we are absolutely clear, and it's the feedback from our customers, that the world is going more and more to hybrid cloud and multi-cloud. And the portfolio that we have assembled is essentially the only portfolio in the industry that can secure and deliver every application in any one of these environments, private cloud, public cloud, increasingly at the edge. in any consumption form factor, so hardware, software, and SaaS. And so we feel very good about the portfolio we have and how it's positioned to drive the architectures of our customers going forward. Where we think we are seeing the more severe slowdown in the short term is in ADCs where customers can actually perhaps sweat the assets for a little longer, but we expect that that demand will resume in short order.

And, Tim, on the maintenance or the renewal question, I'm going to separate out the maintenance renewals, which have obviously been quite strong on the services side, and the software renewals, which are also strong. And you were saying, you know, what are your expectations? When you think about the way we've talked about the business, and FCPs have been the predominant amount of growth that we've seen in our software business, and that's the majority of what comes up for renewal in any given quarter. those have performed largely to our expectations and in many cases growing from the levels that they were when they ended year three. There has been some this year where we've taken a look at years two of the agreement and years three of the agreement where that true forward amount has not been up to the level of expectations that we had that we modeled from previous years as people are very critical on trying to consume very close to what they've contracted for, and so we're not seeing the same overages that we have before, and we think that's probably indicative of the same way that cloud providers are seeing their consumption. So when we say, you know, the renewal base, the renewal base is up substantially from last year, as expected, as this is the first full year of SEP sales when you take a look back three years ago as a comparison.

Okay, thank you.

And the next question comes from the line of Sameek Chatterjee with JP Morgan. Please proceed with your question.

Yeah, thank you, and thanks for taking my questions. I guess for the first one, I think just to clarify, I think, Francois, you made a comment about fiscal 24, talking about double-digit earnings growth. Just wanted to see sort of how you're thinking about top line sort of underpinning that expectation. I know you talked about gross margin improvement as well as operating margin, but sort of maybe give us a bit more color about how you're thinking about the top line underpinning that guide and have a follow-up.

Sameek, I missed part of the question, but is it about top line in fiscal 2024?

Yes, I think you made a comment about double-day earnings growth, so just curious sort of how you're thinking about the top line as you talked about margin expansion being the key driver there.

Yeah. So, look, Sameek, when we look at fiscal 2024, of course, we're not, you know... in a position or have the visibility really to guide to the top line for 2024. But I could give you just a few pointers here. It is clear from where we're at with our ability to ship today that we will ship the vast majority of our backlog you know, in fiscal 2024, either by the end of the third quarter or the end of the fourth quarter. Sorry, by the end of fiscal 23, sorry. By the end of Q3 or the end of Q4 fiscal 2023. So when you look at that on a normalized backlog level in 2024, clearly that's going to represent a headwind to, you know, revenue growth in 24 in the order of six to eight points of growth, you know, given that dynamic. On the other hand, we also see that the, you know, we're seeing a lot of projects that are delayed. And our view is that customers can only sweat their assets for so long. And that at some point, you know, demand is being pent up and demand is going to pick up when that is going to happen. is a bit of an uncertainty, but it's reasonable to assume that we would see some of that at some point in 2024. So I can't give you a position on revenue growth for 2024, but what we can control, of course, is our cost base. And you see that we have made an adjustment to our cost base that will give us meaningful expansion of operating margins in 2024 and secure our ability to deliver double-digit earnings growth in fiscal 2024. Okay, thank you.

And so for my follow-up, I mean, it was on the cost structure, obviously with some of the actions you're taking and the rules you're sort of taking out, you'll operate at a much lower level of operating expenses as opposed to revenue than you have historically I mean, how much of that is sort of sustainable and you can operate at that level for a multi-year period versus just more of a function of how you're looking at the macro and trying to be more conservative around it? Like, is there a more structural upside to how you think about operating margins in operating it at a lower cost structure?

Well, a couple of things there, Samik. Number one is performance. You know, our objective has been and continues to be to drive operating leverage in the business. And we think from where we're at today, at the 30% operating margins for the year, if you look at it in the second half of the year, you know, it's going to be the first half within the 26%, 27% zone. The second half of the year is going to be meaningfully higher than that, you know, when you look at a full year being at 30%. And from there, our intent is to drive further operating leverage in 24 and beyond. And we see the opportunity to do that with a combination of getting more efficient in our business and driving productivity, as well as continuing to drive top-line growth. We said at our analyst day in 2020 that we were going to invest in driving some efficiencies and costs out of the business. We have been doing that. Today we're announcing some changes to our cost base, but whilst we're doing that, we're also doubling down on investments in automation that will allow us to drive operating leverage going forward. So we see that as an ongoing journey of driving operating leverage, which you'll start to see the benefits of that in the second half of this fiscal year, but that will continue in 2024. Okay.

Thank you. Thanks for taking the questions.

Thank you, and the next question comes from the line of Simon Leopold with Raymond James. Please proceed with your question.

Thank you very much for taking the question. First, it does seem as if there's maybe a bit of a potential conflict in sort of the tone of really describing the situation as temporary but taking the action of cutting staff levels and cutting expenses because I guess the expense cuts sort of imply something about the duration of how you see the risks. And I just, I've heard everything you've said. I just feel like maybe it would be helpful to get a little bit more handholding of how you're thinking about the duration and what led you to make the decision. Maybe it's where are the cuts coming from? I appreciate you can't give us all the detail, but a little handholding would help to sort of help understand the potential conflict there.

Simon, thank you for the question. So let me start with saying when we looked at our, you know, we spend quite a bit of time in the first half of our fiscal year looking at the demand signals that we were seeing from our customers. And if you recall, Simon, last year, you know, we had challenges on our revenue in the second half of the year that were driven largely by issues of supply. And at the time we said, We did not want to reduce our staffing levels because this was not a demand issue. It was a supply issue. We also said at the time that if we did see a softening in demand, that that would cause us to relook at our call space and potentially address our staffing levels, and that's exactly what we're doing. This year, we're seeing a softening of demand. And whilst we appreciate that that is driven by macro environment, and it is temporary, we are also being quite disciplined about driving our earnings performance but also ensuring that in this environment we are operating as lean as we can be and as lean as we should be. And that's what's driven our approach to reducing our staffing levels. We do feel that with these staffing levels, we are well positioned to drive growth and capture the opportunity when demand levels normalize and our customers are ready to spend. In terms of giving you a couple of points, Simon, on where we have made some cuts, It's across the board, but if I park it in roughly three categories, in G&A, we have looked at increasing productivity and driving some efficiencies and just, you know, being able to rationalize the G&A organizations for the size of the company we are post-discuts. In sales, we have looked at realigning or consolidating some territories and reconfiguring some of the roles in our go-to-market to have a leaner go-to-market motion and having a focus on the territories that will drive the best returns in the near to medium term. And then in our product organizations, we have looked at all R&D projects that we have underway and really are focusing on the ones that will drive the best returns. And where we have made cuts is on those projects that are perhaps more speculative or have longer-term returns. And all of those really amount to us focusing on our top priority projects and really being leaner and positioned for when demand will normalize. I would add that whilst we're doing that, we are doubling down on investment in our software, our hybrid and multi-cloud portfolio, because we're seeing growing evidence from customers, from architecture coalitions, that we are ideally positioned for where their applications are going, where the security challenges are going, which is really about securing and delivering apps, not in a single infrastructure environment, but across multiple public clouds, private clouds, and the edge, and being able to network all these environments together. And I think we're in a unique position in that, so we're continuing to make these investments. That's very helpful, so thank you for that.

And just one quick follow-up. I know you mentioned that you thought you'd have backlog normalized either at the end of the third or fourth quarter, certainly in fiscal 2024. Can you quantify where backlog was at the end of the March quarter?

We are not in the Our normal course is not to update backlog at any one particular quarter. We talk about it at the end of the year. We tried to highlight to people during this particular call that we did expect to be through most of our shippable backlog by the end of the fiscal year. Whether that's Q3 or Q4, I can't tell you. But we didn't quantify where we were at the end of Q1, and we're not quantifying where we are at the end of Q2.

Thank you for taking the questions.

Yep.

And the next question comes from the line of Mita Marshall with Morgan Stanley. Please proceed with your question.

Great, thanks. A couple for me. Maybe to start with, you know, you mentioned that customers are kind of running their networks at higher utilization of the F5 equipment. Just wondered if you could give a sense of, you know, is that matching kind of previous levels that you've seen in prior kind of macro pullback or just kind of where we are on kind of how hot they're running their networks versus peaks that we've previously seen, if there's any way to contextualize that, maybe as a first question.

I would say on that front, the sample size of customers where we have customers you know, really the ability to see that and understand that is limited. But for those where we can see it, we have a number of customers that are, you know, getting close to or exceeding kind of a, I want to call it a red line, but the maximum they would have normally gone to in normal times. And so that just points to us that at some point they will expand capacity. And this is consistent, actually, with what we have seen in prior macro slowdowns where customers have tended to sweat their assets in this way. And in the past, when we have seen customers sweat their assets this way, we have seen it happen for four to six quarters. Now, every micro slowdown is different in shape and different in how it plays out, but that's what we have seen in the past. What we are also seeing, Medha, that's kind of evidence to this behavior, is that the attach rate, the services attach rate that we see on our platforms, especially the platforms that are four years old and beyond, we're seeing the... the attach rate on these platforms, the maintenance attach rates on these platforms go up, which is also very typical of customers sweating these older assets for a little longer. And that, again, is consistent with what we have seen in prior macro slowdowns. So all of that points to us that that's the behavior of customers, that they're sweating assets, that it's not a a change in their thinking around architecture or a change really in our competitive position, we're seeing customers kind of hunkering down with us for a period of time.

Got it. That's helpful. And then maybe as a follow-up question, obviously a lot of your software revenue tied to kind of these cloud transformation projects are now being delayed a little bit with cloud optimization projects. But is there a way to, you know, is that largely... virtual ADC projects, which are being kind of postponed, but security projects are going ahead. Just trying to get a sense of, you know, is this kind of across the board or are there certain projects that are more security attached that are getting higher prioritization? Anything that would be helpful in terms of what software projects are getting approved versus not.

I mean, I think that, so our security software business, has been more resilient. I would say we're seeing all product lines affected, but our security software business has been more resilient. And for managed services and software as a service, part of our business, which is still a small part of our business overall, but we're seeing that that is affected but continues to grow. Where we are seeing the biggest impact, Meta, is in these large multimillion dollar multi-year projects that typically include our ADC And it could be ADC and attached security. But these projects have enormous scrutiny. We've seen a couple of them where they are approved all the way up to the CIO only for the CO or CEO or the board to come and say, we're not doing these projects. And of course, that happens with these multimillion dollar projects. But it doesn't happen as much with normal deals that are a few hundreds of thousands of dollars. In fact, this quarter, the number, if I just speak in terms of volume, the number of multi-year subscription software deals that we did was up significantly relative to a year ago. But when you look at it in terms of dollars, because the large multi-million dollar projects were those that were most affected or postponed, you saw the impact on our software revenue. So that's the difference we're seeing in terms of the scrutiny on the smaller deals versus the big multimillion dollar deals. And those deals, from the feedback we're getting from customers, are not going away. They're essentially delayed by one or multiple quarters. But we do see that demand coming back down the road.

Great. Thank you.

Thank you.

Due to time constraints, we will take our last question from the line of James Fish with Piper Sandler. Please proceed with your question.

Hey, guys. Most of mine has been asked, but just wanted to follow up. Francois, you actually made the comment that you expect some of the, maybe it was Frank, some of the working capital stuff to kind of work itself out by fiscal Q4. And I know you don't want to talk about backlogs specifically, but You know, it sounds like if it's going to work itself out by fiscal Q4 that we should expect to kind of exit the year at a more normal backlog level now. Is that the right way to kind of think about it at this point? Yes, Jim, that is the right way to think about it. Okay. And just lastly, I know you called out SAS being more resilient and that it's still growing on a year-to-year basis. Just given now that that's become a more resilient part and it seems like it should be at this point material part of the business, any further color as to what percentage of the total recurring software business is now SaaS overall and if it grew actually sequentially?

Yeah, Jim, we have not split that out, and we are not currently splitting that out now.

In terms of, you know, growth year over year, yes, but we just have not split that out yet.

Okay, I understand. Thanks, guys. This concludes today's call. Thank you for attending. You may now disconnect your lines.